Fatten Your Retirement and Cut Your Taxes March 13, 2018
Once again, it’s that time of year. Uncle Sam is reaching into pockets across the country, but what most people forget is that it’s also a time where the rules let you both reduce your taxes and build your retirement.
Quick hint: At the end of this article I will briefly outline a massive tax saving strategy for managers or entrepreneurs in partnerships, LLCs or corporations, but first let’s deal with cutting taxes using contributions to retirement accounts.
Most important: Get your IRA contribution checks in NO LATER than April 16, 2018. Given that it usually takes brokers a couple days to process contributions, it would be smart to have the check at your custodian April 13, 2018 or before. As with many things, the sooner the better. Now would be good.
If you have questions about your IRA, get in touch. Use the contact page on the site.
This is organized by Account Type, so feel free to scroll down to what’s relevant for you.
A few quick notes:
• It is nearly ALWAYS the best idea to make your maximum possible contribution to tax deferred accounts – years of tax free compounding can make a huge difference.
• So whether you get the deduction or not, you should make your contribution.
• If you qualify, choose to make a ROTH IRA contribution unless you absolutely need the tax deduction of a Traditional IRA for some reason. This might mean you have 2 types of IRA accounts. This is because normal withdrawals from ROTH accounts are not taxed. Major advantage in retirement.
• If you are Self Employed with no employees, you should open a SEP IRA immediately. The advantages are big.
• If you are Self Employed with employees, you should look into a SEP IRA or a SEP 401(k) as either may be a good solution for both you and your employees.
Here’s how it works in 2018:
SEP IRAs (For Self-Employed)
- 0 – 25% of your compensation up to $54,000
- Must be sole proprietor, partnership, business owner or earn and report self-employed income
- Eligible employees must receive same percentage contribution
- Report your contribution – typically, SEP IRA contributions come off your Earned Income total on a dollar for dollar basis, so you could drop a tax bracket or two thanks to your contribution
For more info on SEP IRAs you could visit https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-seps-contributions or use the contact page on the site to reach out. I’m happy to answer questions and get you going in the right direction.
Tax Strategy for Execs or Entrepreneurs:
This one is a game changer. I’ve seen it in action and it literally wiped away a high 6-figure tax bill.
Here is the broad outline of how it works, but make sure to seek the advice of an expert if you are going to pursue this strategy and make sure you are comfortable with the outcome if the IRS (or DOL) disallows your actions.
IRS law allows for individuals in closely held business partnerships, LLCs, or Corporations (except S Corps) to buy shares of the company from within a tax deferred account. There are several restrictions, but if you meet the requirements it can be a huge benefit to you in retirement.
A couple key rules (there are more, but these are the broad outlines):
- You must own less than 50% of the company in question, either directly, through an entity, or combined.
- If you, your spouse, or any family members together own more than 50% of the company directly, through an entity or combined, you are not eligible.
- You may not transact business within the IRA. This means no selling or leasing property, lending money, providing goods or services, transferring or using income or assets from the IRA, etc.
- You cannot use the assets in the IRA to benefit yourself or family members prior to retirement in any way.
- The company in question must be appraised by an independent 3rd party prior to share purchase to establish the true value of the shares you wish to purchase inside your IRA.
- Not all custodians will allow the ownership of closely held businesses inside IRA accounts. However, many of the big guys, Charles Schwab among them, do allow this.
Who might this fit and how could it work?
Let’s pretend you are a part owner of a company that is experiencing solid growth and you think the company is going to be worth a lot more in the future. Let’s also pretend that you and the other owners or management plan to sell part or all of the company in a few years.
Let’s pretend the appraisal comes in at $10 per share and when you joined you bought 30,000 shares to ($300,000) equal to 15% of the company.
Now, let’s pretend your company is great at what it does and is growing by about 50% per year (not unheard of for closely held companies). In 5 years that puts your $10 stock in the area of $75 per share, or $2,250,000.
In a normal scenario, you would be required to pay 20% long term capital gains taxes on $1,950,000 of that money, or $390,000 to the Feds.
But in reality, it’s a lot more than $390k lost. You are also losing the investment returns you’d gain on that money for the rest of your life. Even at just 6% and a relatively short 20-year retirement, that $390k lost to taxes would represent nearly $900,000 in lost investment returns. That’s a pretty steep price to pay for an avoidable loss. Because if you are eligible, you wouldn’t have to lose that money to taxes.
Wouldn’t you rather have that money available for you or your family when you retire? Buy those shares in your IRA and that may be exactly how it works out.
It certainly did for one of the people I work with. He was a senior manager that owned nearly 5% of the company he worked in. When the company sold 5 years after he was hired his initial $300k investment had grown to $4 million.
He didn’t pay a dime in state or federal capital gains. Legally.
Now the mandatory disclosure: Neither my firm nor I are tax professionals and do not provide tax advice. The information presented are general guidelines. Check with your tax professional.
Need some help? Feel free to use the contact page on the site to reach out and I’ll help point you in the right direction.
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Invest Smarter, Live Better.
ACI Wealth Advisors, LLC.
Process Portfolios, LLC.